On the Strength of the US dollar: Can it be Explained by Output Growth?
AbstractOne popular view on the current strength of the US dollar is that the higher growth in the US compared to Europe has stimulated foreigners to buy American assets, thereby driving up the exchange rate. In this paper a modified portfolio balance model is presented, in which it is shown that the impact of output growth on the exchange rate depends crucially on the origin of this growth. An improvement of the output gap is shown to actually depress the exchange rate whereas an increase in potential output growth leads to an appreciation, especially if this improvement is likely to be persistent. In an empirical example, it is shown that the equilibrium Dmark dollar rate is indeed positively affected by a positive trend growth differential between the US and Germany, whereas it is negatively affected by a positive output gap differential.
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Bibliographic InfoPaper provided by Netherlands Central Bank, Research Department in its series WO Research Memoranda (discontinued) with number 668.
Date of creation: 2001
Date of revision:
rational expectations; portfolio balance model; Taylor rule; Kalman filter; foreign direct in-vestment;
Other versions of this item:
- P.J.G. Vlaar, 2003. "On the Strenght of the US Dollar: Can it be Explained by Output Growth?," DNB Staff Reports (discontinued) 82, Netherlands Central Bank.
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- F31 - International Economics - - International Finance - - - Foreign Exchange
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